W.12_Lilly Wasitova_The Big Mac Index


Problem Statement

 

To follow up on my blog # 11 regarding the study of Gold Price vs. Exchange Rate, it is interesting to consider the theory of Purchasing Power Parity (PPP) into the picture, since the PPP has been using US Dollar as the reference to determine the relative values of currencies.

 

As The Economist [6] has introduced the most famous example of PPP by using the Big Mac Index to be used as an index to determine the relative value of other items, the study here will be using the Big Mac Index from [6] from 7 (seven) different currencies and the average Gold Price from [4] from the year 2007 to 2011.

 


Table 1 : Big Mac Index [6] and Gold Price [4] from 2007 to 2011

 

 

Alternative Solutions

 

The Big Mac Indexes shown in the below Graph are showing an increasing value for the past two years and the highest index is for Switzerland [CHF] whereas the lowest is for Hong Kong [HKD]. The trend line used is the 3rd Grade Polynomial Trend Line, as it was already used in the previous studies.

 


Figure 1 : The Big Mac Index from 2007 to 2011

 

As a comparison is the Graph of the Gold Price USD/Oz. from the same period and showing an increasing trend from the beginning as below:

 


Figure 2 : The Gold Price [4] from 2007 to 2011 with trend-lines

 

 

Selection Criteria

 

The selection criteria will be the same for all approaches, namely:

  • Data period from the year 2007 to 2011, using average values.
  • The 3rd Order Polynomial Trend Line and R2 coefficient
  • To convert the Big Mac Price to Ounce of Gold and see the trends

 

Analysis and Comparison of Alternatives

 

To compare the input data and graphs, the R2 coefficient comparison for the all Big Mac Indexes are very acceptable as well as the Gold Price Coefficient, as shown in the below table:

 


Table 2 : R2 coefficient Result for Big Mac Indexes and Gold Price

 

The R2 Coefficient for the Chinese Yuan [CNY] is the worse, since the graph is almost flat compared to others, whereas the US Dollar is on zero line as reference line for Over or Undervalue of the currencies.

 

 

Selection of the preferred alternatives

 

Converting the Big Mac Price to Ounce of Gold to see gives us the below table and graph:


Table 3 : Big Mac Price in Ounce of Gold, using average Gold Price USD/Oz.

 


Figure 3 : Big Mac Prices in Ounce of Gold, using average Gold Price USD/Oz. and their trend lines

 

 


Table 4 : R2 coefficient Result for Big Mac Prices in Oz of Gold

 

 

Comparing the trends in Figure 3 and the R2 Coefficients in Table 4, we can see that

  1. The Big Mac Price for USA [USD] is no longer in zero line
  2. For the next Period there are only three inclining trend lines namely for Switzerland [CH], Euro Based Countries [EUR] and Singapore [SGD]
  3. For the next Period there are three declining trend lines for Indonesia [IDR], Hong Kong [HKD] and China [CNY]
  4. Perfect R2 Coefficient for Big Mac Price in Gold for China [CNY] R2 = 1, compared to the worse in its Big Mac Index
  5. All other R2 Coefficient are very acceptable, close to perfect trend.

 

Performance Monitoring & Post Evaluation of Results

From the above calculation and above analysis, we can say that:

  1. To make the common approach of the 3rd Order Polynomial Tend Line to all set of selected data is the right approach and giving the very acceptable values.
  2. Taking the Big Mac Index and convert the values to Gold Price is saying that the US Dollar has a different behavior and cannot be seen as the stable reference for the Index.
  3. With the Gold Price reference, the trends vary for different currencies, and behave differently than if only considering the Big Mac Index as the Purchasing Power Parity application.

 

 

References:

  1. Sullivan, William G., Wicks, Elin M. & Koelling, C. Patrick (1942), Engineering Economy 15th Edition, Singapore: Prentice Hall, Inc.
  2. Michael Bassard & Diane Riter (2010), The Memory Jogger 2nd Edition, Canada, GOAL/QPC
  3. XE, The World’s Favorite Currency Site http://www.xe.com/ucc/
  4. KITCO http://www.kitco.com/scripts/hist_charts/yearly_graphs.plx
  5. John K. Hollmann, PE CCE (2006), Total Cost Management Framework, A Process for Applying the Skills and Knowledge of Cost Engineering 1st Edition, USA, AACE International – The Association for the Advancement of Cost Engineering
  6. The Economist, http://www.economist.com/node/12991434?story_id=E1_TNJJTQPQ

 

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About Lilly Wasitova

Goal oriented professional who like to have fun
This entry was posted in Lilly Wasitova, Week #12. Bookmark the permalink.

2 Responses to W.12_Lilly Wasitova_The Big Mac Index

  1. DrPDG says:

    AWESOME again, Bu Lilly!!!!

    You are “killing two birds with one stone” by linking your blog posting to your paper and you have picked a VERY interesting and appropriate topic that I am sure is going to be well received in the “Cost Engineering” community!!

    Just be sure to remember that you CANNOT apply to take the CCC/E exam unless your paper is FINISHED, which means you really need to be targeting no later than 22 July to wrap up, just in case there I find a problem in your paper……

    BR,
    Dr. PDG, Boston, MA

  2. Lilly Wasitova says:

    Thank you so much Pak … am working on it and I am confident to have the paper ready before due date.

    I am still working on the theory part of PPP and looking for some great references … still browsing browsing …

    Warm regs,
    Lilly

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